European Scrutiny Committee Contents


7 Financial services

(a)

(31816)

12386/10

+ ADDs 1-2

COM(10) 368

(b)

(31818)

12387/10

COM(10) 369

(c)

(31836)

12346/10

+ ADDs 1-2

COM(10) 371

Draft Directive on deposit guarantee schemes (recast)




Commission Report: Review of Directive 94/19/EC on deposit guarantee schemes



Draft Directive amending Directive 97/9/EC on investor compensation schemes

Legal base(a) and (c) Article 53(1) TFEU; co-decision; QMV

(b) —

Documents originated12 July 2010
Deposited in Parliament(a) and (b) 22 July 2010

(c) 21 July 2010

DepartmentHM Treasury
Basis of consideration(a) and (b) EM of 12 September 2010

(c) EM of 17 September 2010

Previous Committee ReportNone
To be discussed in CouncilNot known
Committee's assessmentPolitically important
Committee's decision(b) Cleared, (a) and (c) not cleared, further information requested; Reasoned Opinion on (c) recommended

Background

7.1 The Deposit Guarantee Schemes Directive, Directive 94/19/EC, as amended, governs the operation of statutory deposit guarantee schemes in the European Economic Area, including the UK's Financial Services Compensation Scheme. The Directive was amended, following the financial crisis, in March 2009, by Directive 2009/14/EC. The main change was to increase the coverage level to €100,000 (£83,490) by 31 December 2010 — under the earlier legislation Member States operated widely differing levels of coverage. When proposing the 2009 Directive the Commission said it would undertake a fuller review of the Deposit Guarantee Schemes Directive.

7.2 The Investor Compensation Schemes Directive, Directive 97/9/EC, ensures compensation for clients receiving investment services from investment firms (including credit institutions) in specific circumstances where the firm is unable to return money or financial instruments that it holds on the client's behalf because it is in default. Examples of where compensation may occur are in cases of theft, embezzlement, fraudulent misrepresentation, unintentional errors, negligence or breakdown in systems and controls. If the firm is unable to pay compensation itself due to insolvency national schemes pay compensation on eligible claims. The Directive does not cover investment risk.

The documents

7.3 The draft Directive, document (a), is to recast, that is revise and consolidate, the Deposit Guarantee Schemes Directive, with the aim of improving protection for depositors and further harmonising the rules governing schemes. The key elements of the draft Directive are:

  • confirmation that coverage level for deposits will increase to €100,000 from 31 December 2010, when it will become the minimum and maximum level that schemes can offer;
  • Member States outside the eurozone can set a coverage level in their own currency, equivalent to the value of €100,000, which can be rounded up by up to €2,500 (£2,087) — at current exchange rates the coverage level in sterling could be rounded to £85,000;
  • review of this level every five years, unless unforeseen events necessitate an earlier review;
  • provision for depositors to be reimbursed within seven days of the failure of an institution — the current provision is for reimbursement within 20 working days, plus a further 10 days in the event of exceptional circumstances;
  • depositors would not have to make an application for reimbursement;
  • requirement for deposit takers to inform schemes early if a failure becomes likely, in order to facilitate the faster payout deadline;
  • requirement for deposit takers to provide information about the aggregated deposits of a depositor (a so-called 'single customer view') at any time;
  • stipulation that, in order to facilitate the payout process in cross-border situations, the host scheme should act as the single point of contact for depositors in a branch in another Member State — this would include communications with depositors and paying out on behalf of the home state scheme;
  • proposals for the sound financing of schemes through a four-step approach — they must have access to a "pre-fund" equivalent to 1.5% of covered deposits by 2020, if additional funding is needed then members of the scheme, that is deposit-taking institutions, must pay extraordinary contributions of up to 0.5% of eligible deposits within seven days of a failure, a requirement for schemes to lend to each other from 2020 in certain circumstances and other funding arrangements could be made as a contingency, such as borrowing from governments;
  • deposit takers' contributions to schemes should be determined by risk-based levies so that contributions reflect the risk associated with the institution rather than just its size — the Commission has proposed a formula for calculating this;
  • widening the range of businesses eligible for deposit protection so that all businesses, apart from financial institutions, would be covered, not just small and medium-sized firms;
  • giving the proposed European Banking Authority a role in administrating borrowing and other forms of cooperation between schemes;
  • giving the European Banking Authority and the European Forum of Deposit Insurers[21] a role of regularly peer reviewing and stress testing schemes to ensure that they comply with the requirements of the Directive; and
  • introducing some limitations on the use of a deposit guarantee scheme's funds for resolution of a failed institution.

7.4 The draft Directive is accompanied by the Commission's full impact assessment and a summary of the assessment.

7.5 The Commission Report of its review of the Deposit Guarantee Schemes Directive, document (b), covers those issues which are not, or not entirely, dealt with by the draft Directive, document (a). It discusses:

  • the appropriateness of a fixed coverage level of €100,000;
  • the appropriateness and arrangements for providing full coverage for certain temporarily increased account balances;
  • the benefits and costs of introducing a pan-European Deposit Guarantee Scheme;
  • harmonisation of the scope of products and depositors covered, including the specific needs of small and medium-sized enterprises and local authorities;
  • the link between deposit guarantee schemes and alternative means of reimbursing depositors, such as emergency payout mechanisms; and
  • briefly, the link between deposit guarantee schemes and the Commission's work on bank resolution.[22]

7.6 The Report is relatively short and the Commission says that it should be read in conjunction with the draft Directive, document (a).

7.7 The second draft Directive, document (c), is to amend the Investor Compensation Schemes Directive. It aims to:

  • increase the protection provided under the present Directive and strengthen confidence in the use of investment services;
  • address regulatory loopholes and problems experienced in the operation of national schemes; and
  • reflect changes in the regulatory framework, both as the present Directive was modelled on the Deposit Guarantee Schemes Directive, which has since been amended and for which further changes are proposed, as in document (a), and as it complemented the Investment Services Directive, which has now been replaced by the Market in Financial Instruments Directive regulating provision of investment services in the EU.

7.8 The draft Directive would:

  • increase the minimum level of EU compensation payable to investors from €20,000 (£16,350) to a harmonised minimum and maximum level of €50,000 (£40,875);
  • Member States outside the eurozone could set a coverage level in their own currency, equivalent to the value of €50,000, which could be rounded up by up to €2,500 (£2,087);
  • remove the co-insurance option under which investors could bear a proportion of up to 10% of the loss within the compensation limit. Currently, if an investor has an eligible claim for £1000, they could receive as a minimum £900 compensation, bearing up to £100, or 10%, of the loss themselves — many Member States, including the UK, have already removed co-insurance;
  • clarify that all core investment activities covered under Market in Financial Instruments Directive should be subject to the Investor Compensation Schemes Directive — under the former Directive not all investment firms are authorised to hold client assets, but this would extend coverage to all instances where firms hold client assets, irrespective of whether they have authorisation to do so;
  • extend cover in the case of the default of a third party custodian resulting in the investment firm not being able to return the client's assets, given that under the Market in Financial Instruments Directive investment firms may place assets with a third party for safekeeping;
  • extend cover similarly it relation to the Undertakings for Collective Investments in Transferable Securities (UCITS) Directive, an EU harmonised framework for investment funds, which requires funds to place assets with a depositary for safe-keeping and allows the depositary to delegate this function to a sub-custodian. Coverage would be provided to UCITS unit holders if there were a loss of assets due to the failure of a depositary of a UCITS scheme or a sub-custodian thereof;
  • require schemes to build up a pre-fund for 0.5% of the value of the investments covered in the ten years following implementation of the Directive;
  • ensure an additional 0.5% annual levy if the pre-fund is insufficient (unless this jeopardises the stability of the financial system of the Member State);
  • provide for access to alternative short-funding arrangements on a commercial basis;
  • provide for a borrowing mechanism between national schemes — Member States would have to make 10% of their pre-fund available for lending to other schemes, but a scheme could only borrow up to 20% of the total amount of monies available in each instance, borrowed funds would only be used to pay Investor Compensation Schemes Directive compensation, the proposed European Securities and Markets Authority would confirm that these requirements were met and state the amounts to be lent by each scheme, which would be in proportion to the amount of the covered investments, and loans would be repayable within five years and would accrue interest at the European Central Bank's rate for its marginal lending facility;
  • provide for partial payouts to be made if claims are not settled within nine months of the determination of default; and
  • provide for investors to receive more detailed information about what is covered and not covered under compensation schemes.

7.9 The draft Directive is accompanied by the Commission's full impact assessment and a summary of the assessment.

7.10 The Commission has also published at the same time as these documents a White Paper on insurance guarantee schemes, which is the subject of another chapter in this report.[23]

The Government's view

7.11 In relation to the draft Directive to recast the Deposit Guarantee Schemes Directive, document (a), the Financial Secretary to the Treasury (Mr Mark Hoban) tells us that the Government believes that compensation plays a vital role in ensuring ongoing depositor confidence and that recent events have highlighted the importance of this. He comments that the UK's Financial Services Compensation Scheme leads the way in the EU and already goes further in many areas than required by the current Directive, such as aiming to pay out within seven days, implementing single customer view and having the capacity to pay out on behalf of another scheme. He says that the Government therefore fully supports the principle of improving EU-wide depositor protection by raising minimum standards of deposit guarantee schemes across the EU, but that it would not support further EU harmonisation if this led to a reduction in protection currently offered to UK depositors.

7.12 In more detailed comments the Minister says that:

  • the Government supports the proposals to provide a harmonised coverage level at €100,000 (£83,490) and current provisions for non-euro countries to convert the coverage level to their own currencies;
  • its preference is for a round sterling coverage limit, which at current exchange rates could be set at £85,000 in order to ensure consumer certainty;
  • the new coverage limit increases protection for depositors and provides a level playing field for financial institutions across the European Economic Area;
  • the Government supports proposals for better stress-testing of schemes, transparency and peer review in line with its objective with securing well-functioning schemes, with streamlined payout procedures;
  • it plans to seek important improvements during Council working group negotiations to ensure that the proposed Directive avoids imposing unnecessary burdens on the UK financial services industry, while at the same time delivering improvements to depositor protection and consumer confidence;
  • it is currently considering the implications of the Commission's funding proposals and will take account of their impact on the Financial Services Compensation Scheme, on industry and the implications for consumers;
  • the Commission's proposal for requiring schemes to lend to one another could have fiscal consequences for national governments and raises questions about how mutual borrowing would work in practice — the Government does not believe that it is appropriate to introduce mandatory mutual borrowing at this stage;
  • the Government supports faster payout for depositors — the Financial Services Compensation Scheme currently aims to compensate the majority of depositors within seven days of the failure of an institution;
  • the Government will seek to ensure that the proposed Directive sets payout deadlines that are realistically achievable for schemes and will push for exemptions where seven-day payout is not possible; and
  • it will protect the Financial Services Compensation Scheme's existing capacity to participate in resolution activities.

7.13 The Minister makes no comment on the policy implications of the Commission Report of its review of the Deposit Guarantee Schemes Directive, document (b).

7.14 On the second draft Directive, document (c), to amend the Investor Compensation Schemes Directive, the Minister first sets out a Government stance that is very similar to that in relation to the other draft Directive, document (a):

  • compensation plays a vital role in ensuring ongoing investor confidence and that recent events have highlighted the importance of this;
  • the Financial Services Compensation Scheme leads the way in Europe and goes further in many areas than required by the proposed Directive, such as covering losses resulting from breaches of conduct of business requirements and by providing a higher compensation limit;
  • the Government therefore fully supports the principle of improving EU-wide investor protection by raising minimum standards of investor compensation schemes across the EU; and
  • it would not, however, support further EU harmonisation if this led to a reduction in protection currently offered to UK investors.

7.15 The Minister then tells us that the Government supports the principle of updating the Investor Compensation Schemes Directive in the light of changes in the past thirteen years, although it plans to argue for continued national discretion in the operation of compensation schemes. He says that the Government will seek important improvements to the draft Directive during Council negotiations to ensure that it avoids imposing unnecessary burdens on the EU investment industry, while at the same time delivering improvements to investor protection and confidence.

7.16 Elaborating on this the Minister first discusses detailed funding requirements, saying that:

  • the Government will argue for a more proportionate approach that recognises that member States are best placed to ensure schemes are able to meet their obligations;
  • although discussions on pre-funding within the deposits sector are more advanced, unlike deposits, which are used by the depositor to live on and to pay day-to-day bills, investments are used for longer term capital accumulation and so the argument for pre-funding the investment sector is weaker;
  • there remain arguments supporting the introduction of pre-funding, including that the "polluter pays" and that it is countercyclical; and
  • disproportionate levels of pre-funding would take away large sums of investor money, affecting investors through reduced investment returns, without increased protection.

7.17 On mutual borrowing, the draft Directive provisions allowing a national scheme to borrow from other national schemes if they have exhausted their pre-fund and additional levies, the Minister says that the Government has strong reservations about these requirements and will work closely with other Member States to argue for their removal. He notes particularly the provisions could impact Member States that provide backing to their schemes.

7.18 In relation to cover for default of third parties and UCITS depositaries the Minister comments that:

  • while the draft Directive may provide increased investor protection, it is important that it takes into account decisions to be made during forthcoming work on UCITS with respect to depositaries and liability; and
  • discussions on extending compensation to loss by depositaries of UCITS should be informed by negotiations on UCITS depositaries, which are due to start at the beginning of 2011;
  • it is unclear why the proposals cover UCITS depositaries but not UCITS management companies, which are covered in the UK by the Financial Services Compensation Scheme.

7.19 Turning to compensation limits the Minister notes that the draft Directive would require the UK to reduce its compensation limit from £50,000 to £40,875 (before rounding) and says that:

  • the Government believes that Member States should be free to set higher compensation limits in recognition of differences between Member States in terms of their investment markets;
  • it would, however, support increasing the minimum compensation limit across the EU above €20,000; and
  • it seeks to ensure that requirements for partial compensation payments do not lead to legal and practical difficulties, and unnecessary costs in reclaiming partial compensation paid out on invalid claims.

7.20 The Minister concludes that the Government's overarching objective is to ensure the draft Directive affords an appropriate level of protection to retail investors without placing unnecessary burdens on firms or disproportionately affecting investor returns.

7.21 The Minister tells us that the Government is liaising with affected stakeholders to give them an opportunity to share their views on the two draft Directives. On the draft Directive to recast the Deposit Guarantee Schemes Directive, document (a), the Financial Services Authority will be consulting on changing the coverage level to €100,000 (£83,490) later in the year. On the other draft Directive, document (c), the Government hopes gain a more developed understanding of the cost impacts of the proposal. In relation to the Commission's impact assessments the Minister says, for the first draft Directive, document (a), that the Government will seek further information on the impacts for UK firms and continue to consider the impact of the proposal throughout negotiations. On the second proposal, document (c), the Minister notes that the draft Directive has significant potential regulatory impacts and that the Commission's assessment does not include a specific estimate of the costs to industry or the effect these proposals would have on investment returns for investors. He says that, as part of the consultation process, the Government is seeking further information on the likely impacts from UK firms and will produce an impact assessment using this information.

Subsidiarity

7.22 We are concerned that the provisions in the draft Directive to recast the Deposit Guarantee Schemes Directive, document (a), and the draft Directive to amend the Investor Compensation Schemes Directive, document (c), to allow a scheme to require support from schemes in other Member States may not accord with the principle of subsidiarity. Such provisions risk introducing moral hazard. That is a scheme could undertake inappropriate, careless or risky action because it was relying on a fail-safe mechanism. To avoid introducing moral hazard it would be better not to have recourse to other Member States' schemes, but to have each Member State ensure that members of a scheme take full responsibility themselves. In other words the draft Directives, would not, as they stand in relation to this aspect of the proposals, produce a result that was, in the words of Article 5 TEU, "better achieved at Union level" and therefore do not meet the principle of subsidiarity.

7.23 We understand that Sweden's Riksdag has taken a similar view of the two draft Directives and has submitted Reasoned Opinions to this effect under Protocol No 2 to the TEU and the TFEU. We understand also that Germany's Bundesrat and Bundestag may also offer a Reasoned Opinion on the draft Directive to recast the Deposit Guarantee Schemes Directive. The reasons for our view are set out in the Annex to this chapter.

Conclusion

7.24 We clear the Commission Report of its review of the Deposit Guarantee Schemes Directive, document (b), from scrutiny. As for the two draft Directives, documents (a) and (c), whilst we note the Government's support in principle for the proposals we will wish to consider the documents further in the light of information we should like to have from the Government about progress in negotiating the problems it has identified to us, about the outcome of its consultations and about any impact assessments it develops. Meanwhile the documents remain under scrutiny.

7.25 As for subsidiarity, the deadline for submission on a Reasoned Opinion of the draft Directive to recast the Deposit Guarantee Schemes Directive, document (a), has expired. So our Chairman will write to the presidents of the three EU institutions concerned to draw their attention to our view. However the deadline for a Reasoned Opinion on the draft Directive to amend the Investor Compensation Schemes Directive, document (c), does not expire until 25 October 2010 and a draft Reasoned Opinion to be submitted by the House of Commons is contained in the Annex. So we invite the House to agree a resolution in the following terms:

"That this House considers that the draft Directive to amend the Investor Compensation Schemes Directive does not comply with the principle of subsidiarity, for the reasons set out in the Annex to chapter 7 of the Third Report of the European Scrutiny Committee (HC 428-iii); and in accordance with article 6 of the Protocol on the application of the principles of subsidiarity and proportionality, instructs the Clerk of the House to forward this reasoned opinion to the presidents of the European institutions."

7.26 In view of the proximity of the 25 October deadline, we request that the above Motion be taken on the floor of the House and not debated in a European Committee.

Annex

Draft Reasoned Opinion of the House of Commons

7.27 Submitted to the Presidents of the European Parliament, the Council and the Commission, pursuant to Article 6 of Protocol (No 2) on the Application of the Principles of Subsidiarity and Proportionality

Draft Directive amending Directive 97/9/EC on investor-compensation schemes (12346/10)

Relevant Treaty provisions

1.  Article 5(3) of the Treaty on European Union (TEU) states:

"Under the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level.

"The institutions of the Union shall apply the principle of subsidiarity as laid down in the Protocol on the application of the principles of subsidiarity and proportionality. National Parliaments ensure compliance with the principle of subsidiarity in accordance with the procedure set out in that Protocol."

2. Article 12(b) TEU further states that:

"National Parliaments contribute actively to the good functioning of the Union [...] by seeing to it that the principle of subsidiarity is respected in accordance with the procedures provided for in the Protocol on the application of the principles of subsidiarity and proportionality".

Aspects of the Directive which do not comply with the principle of subsidiarity

3. The House of Commons considers that the draft Directive amending Directive 97/9/EC on investor-compensation schemes does not comply with the principle of subsidiarity in the following respect: the borrowing last resort mechanism between national schemes in Article 4b does not fulfil an objective that can "be better achieved at Union level".

Reasons

4. In its explanatory memorandum, the Commission gives the following justification for establishing a last resort borrowing mechanism between Member State investor-compensation schemes:

"Together with the establishment of consistent funding rules between Member States, the introduction of cooperation arrangements among national schemes will provide greater protection to investors and promote investor confidence in investment services.

"The system is based on the principle of solidarity between the national schemes. According to the proposed Article, a borrowing mechanism among schemes is introduced as a last resort tool.

"These measures should provide schemes with an alternative back up source of funding, under specific conditions and on a temporary basis. They will also facilitate a closer relationship and better on-going coordination between national schemes and will act as an incentive to develop more harmonized practices and working procedures."

5. The Commission explains that national "schemes should have the right to borrow from the other schemes if their funds are insufficient to cover their immediate needs", and that "a portion of ex ante funding in each compensation scheme will have to be available for lending to other schemes."

6. The House of Commons considers it likely that the primary objective of the borrowing mechanism — "to provide greater protection to investors and promote investor confidence in investment services" — will not be achieved. This is because such a mechanism could introduce moral hazard in investment services, the logic being there is a higher risk of a national scheme underwriting inappropriate, careless or risky investments when it knows that it can rely on a back-up source of credit. The House of Commons considers that neither the assessment of borrowing requests by the European Securities and Market Authority nor the obligation to repay the loan within five years will mitigate this risk.

7. To avoid introducing moral hazard it would be better not to have recourse to other Member States' schemes, but, consistent with the principle of subsidiarity, for each Member State to ensure that members of the investor-compensation scheme take full responsibility themselves. Like Sweden's Riksdag the House of Commons considers that, in order to achieve investor protection and confidence, there must be an incentive for compensation schemes of this kind to be adequately funded at national level; and it must be for central governments to ensure that an investor compensation scheme can fulfil its commitments. In addition, the House of Commons considers that, as a general rule of investment, risk should be guaranteed where it arises because that is where it is best assessed and where action may be taken in relation to it.

8. In light of the observations above, and in the absence of qualitative and quantitative indicators provided by the Commission to the contrary, the House of Commons cannot see why, by reason of its scale or effects, action by the EU in the form of the compulsory borrowing mechanism, as opposed to separate action by Member States, would better fulfil the objective of giving greater protection to investors and promoting confidence in investment services. On the contrary, the proposed borrowing mechanism may lead to less protection for investors and less confidence in investment services. This aspect of the draft Directive would not therefore produce a result that was "better achieved at Union level" and does not comply with the principle of subsidiarity.





21   See http://www.efdi.net/aboutUs.asp.  Back

22   (31646) 10394/10: see HC 428-i (2010-11), chapter 70 (8 September 2010). Back

23   (31843) 12360/10 + ADDs 1-8: see chapter 8. Back


 
previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2010
Prepared 26 October 2010